Japan: Another Season of Downturn Abe?

January 25, 2013

by Milton Ezrati

of Lord Abbett

Japan has a new prime minister, Shinzo Abe. He led the once-dominant Liberal Democrat's Party (LDP) in a return to power last month. The campaign focused on economics—hardly a surprise, given that Japan is again in recession after two decades of alternating between stagnation and recession. Mr. Abe has used bold rhetoric, atypical of Japanese politicians, to answer the question of how he would help. Behind the tough talk, however, are the same old LDP "solutions" that have failed in the past. Mr. Abe will have to do better to get his economy moving again. Top 5 Advisors' Biggest Concerns in 2013, with

The new prime minister is determined to achieve quick results. He knows that his party lacks popularity. The only reason the Japanese public opted for him was because the existing government, under Japan's Democratic Party, had failed so miserably and had recently doubled sales taxes, which is hardly a reasonable answer to recession. With the next vote six months away and the next only a year and a half later, and the public remains sensitive to the LDP's past failings, including Mr. Abe's the last time he was prime minister. Abe's three-part program responds to these political imperatives. He would: 1) institute massive new infrastructure spending of ¥10 trillion ($119 billion), or about 2% of Japan's gross domestic product (GDP); 2) insist on an aggressive infusion of liquidity by the Bank of Japan around a 2% inflation target instead of the present, more conservative target of 1%; and 3) start a "comprehensive plan to fight the strong yen."(note 1)

So far, markets have embraced these plans. Major Japanese stock indexes have risen smartly since the election, while the value of the yen has already dropped almost 10% against the dollar. Of course, equity investors cannot help but get enthusiastic about the prospect of easier money and a flood of government spending, even though it promises to raise public debt outstanding to a whopping 240% of the economy.(note 2) Japanese equity investors also cannot help but welcome the yen's retreat, which itself is a response to the flood of debt and prospects of a renewed flow of central bank liquidity, especially the new prime minister's determination to purchases foreign debt as a way to manage down the yen's foreign exchange value. It is noteworthy in this regard that exporters have led Japan's recent stock market rally.

But for all the initial market enthusiasm and upbeat feeling about immediate economic prospects, Mr. Abe's program is at base inadequate. For all the tough, dynamic-sounding rhetoric, Mr. Abe has simply restated standard, LDP policies. Japan's debt is high because the LDP has long used infrastructure spending to goose the economy and, incidentally, channel government funds into contractors, regions, and other party supporters. This proposed ¥10 trillion spending program hardly deviates from that script. Though the emphasis on quantitative easing for the Bank of Japan and inflation targets are new, the net result of using the central bank to absorb government debt hardly is. Nor is the recent effort to force down the yen's foreign exchange value. On the contrary, the promotion of exports through a cheap yen policy has underlain the LDP's entire development strategy since the mid-1950s. To be sure, today's approach of buying foreign debt is a less obvious currency-manipulation technique than Japan once used, and China still uses, but it is a small fig leaf indeed.

Such policies, having failed to sustain growth during the last 20 years, will have still more trouble going forward.(note 3) The biggest problem is Japan's increasingly adverse demographics. The rapid aging of the country's population requires new answers. Abe, by simply repeating the LDP positions in bolder language, offers nothing to address the economic strains implicit in the relative shortfall of working-aged people in the population. He makes no mention, for instance, of longer working lives or an increase in the participation of women in the workforce. Nor has Abe, despite endless advice from academics and Japan's own government agencies, plans to deregulate this heavily controlled, top-down economy in ways that would encourage innovation and startups, two things that might help Japan handle its demographic imperatives and meet the competitive challenges of China and the rest of Asia. Indeed, the prime minister's plans to promote exports as a growth engine work against an adjustment to Japan's sad demographic reality. With such a large proportion of the population retired and no longer actively producing, policy would do better to shift the country from its former role as the world's workshop and cultivate a more consumer-based growth model.

Without such structural reforms, fiscal and monetary stimulus can at best have only short-lived effects. That has been Japan's experience for more than two decades. The new LDP government promises only a rerun. Short-term positives might serve the reelection hopes of Mr. Abe and the LDP, but if this government, however tough its talk, refuses to consider the economy's underlying structural needs, Japan will remain mired in the subpar economic performance with which it has long since become associated. Its stock market will face yet another disappointment.

1 "Japan's Leader's Plans for Growth Are Put to the Test," The Wall Street Journal, January 9, 2013, and "Go on Mr. Abe, Surprise Us," The Economist, December 22, 2012.

2 Ministry of Finance (Japan).

3 For historical approach to LDP policy, see Milton Ezrati, Kawari (2000); updated data from the Ministry of Trade and Industry (Japan).